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Board Report: 2015-SR-B-005 March 26, 2015

Review of the Failure of Waccamaw Bank

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Supervision of Waccamaw

FRB Richmond complied with the examination frequency guidelines contained in CBEM section 1000.1 for the time frame we reviewed, 2007 through 2012, and conducted regular offsite monitoring. During this time period, FRB Richmond and the State conducted four full‑scope examinations, five target examinations, and one visitation related to an asset swap transaction. Supervisory activity during the time frame under review resulted in three enforcement actions: a board resolution, a written agreement, and a PCA directive. FRB Richmond also implemented applicable PCA provisions. As shown in table 1, Waccamaw's CAMELS composite rating declined from 2 to 5 in less than three years.

Table 1: Waccamaw Supervisory Overview
Examination CAMELS composite rating CAMELS component and risk management ratings Supervisory actions
Start date Report issue date Scope Agency
Capital Asset
Management Earnings Liquidity Sensitivity Risk
09/24/2007 11/16/2007 Full FRB Richmond 2 2 2 2 2 2 2 2  
02/02/2009 06/05/2009 Full State 3 3 4 3 3 3 3 3 Board resolution adopted 07/16/2009
08/31/2009 02/04/2010 Target FRB Richmond 4 4 4 3 5 3 3 3 Troubled condition designationa
01/25/2010 07/30/2010 Full FRB Richmond (joint) 5 5 5 5 5 5 4 5 Written agreement effective 06/14/2010
09/27/2010 01/28/2011 Target FRB Richmond 5 5 5 5 5 5 4 5  
01/19/2011 05/02/2011 Visitation FRB Richmond - - - - - - - -  
03/14/2011 07/05/2011 Full State  (joint) 5 5 5 5 5 4 4 5  
06/27/2011 07/19/2011 Target FRB Richmond 5 5 5 5 5 4 4 5  
10/17/2011 01/06/2012 Target FRB Richmond 5 5 5 5 5 5 5 5 PCA directive issued 12/02/2011
02/06/2012 04/24/2012 Target FRB Atlantab (joint) 5 5 5 5 5 5 5 5  

Source: Waccamaw examination reports, 2007 through 2012.

aA state member bank is in troubled financial condition, if it (1) has a composite rating at its last examination of 4 or 5; (2) is subject to a cease and desist order or formal written agreement that requires improvement to the financial condition of the institution; or (3) is expressly informed by the Board or the Reserve Bank that it is in troubled condition. Return to table

bAt the time of this examination, Waccamaw's appeal related to FRB Richmond's decision to disallow the $16 million in preferred stock, as regulatory capital was still ongoing. As a result, FRB Atlanta performed this examination to avoid any conflict of interest. Return to table

While this rapid CAMELS composite rating decline is somewhat unique compared with our prior failed bank reviews, we noted the following instances where issues outlined in our Summary Analysis of Failed Bank Reviews were similar to Waccamaw's supervisory history:

  • Different approaches to aggressive growth strategies: Like the FRB Richmond supervisory team for Waccamaw, many Reserve Bank examination teams questioned the advisability of aggressive growth strategies but did not take aggressive action. By contrast, certain supervisory teams requested that specific institutions refrain from additional growth.
  • Limitations of PCA assessments: We noted instances in which specific state member banks remained well capitalized under PCA guidelines, even though the applicable examination team noted that the banks' capital position did not support its risk profile prior to its PCA status declines.
  • Financial performance declines as a prerequisite for aggressive supervisory action: In many instances, we noted that examiners detected many of the risks that eventually contributed to the failure, but refrained from taking aggressive supervisory action until the bank experienced declines in financial performance. As part of this theme, we highlighted the need for a forward-looking examination approach that involves clear and forceful communications during stable economic periods.

We address these common supervisory issues below, and the subsequent discussion in our findings and recommendations focuses on the unique supervisory aspects associated with this particular failure. This Supervision of Waccamaw section follows a topic-based approach rather than providing a detailed description of the facts and circumstances associated with each examination conducted during the five years preceding the failure. In terms of the unique supervisory history associated with this failure, our findings and recommendations focus on (1) the need to preserve Reserve Bank supervisory records, (2) the circumstances surrounding Waccamaw management's vetting of an asset swap transaction with FRB Richmond, (3) the appeals process for material supervisory determinations, and (4) examination report content that provides an inaccurate account of actual supervisory history.

Supervisory Approach to Aggressive Growth Strategy

In its 2007 five-year strategic plan, Waccamaw noted management's intent to expand the bank's branch network and grow total assets to $1 billion by 2013. During a September 2007 FRB Richmond full-scope examination, examiners reported that management planned to open six new branches in 2007. In response to management's aggressive growth plans, examiners encouraged management to proactively implement the bank's branching strategy by balancing growth with improvements to controls and risk management practices. Further, examiners warned that (1) earnings retention alone would not support management's plan for branch expansion and (2) branch network expansion would place pressure on the bank's earnings. During the same examination, FRB Richmond examiners highlighted declines in the bank's local real estate market. Despite the warnings from examiners concerning management's growth plans and signs of initial declines in the local real estate market, management continued to grow its CRE and ADC portfolio well into 2008.

FRB Richmond responded to management's questionable business strategy in a manner similar to the supervisory approach that we noted in many prior state member bank failures. In those failures, examiners apprised management of the risks associated with the relevant strategy and questioned the advisability of that strategy but refrained from taking more aggressive action. By contrast, Reserve Bank examiners in certain other failures responded to questionable business strategies by taking a more aggressive approach that included requesting that management refrain from additional growth. Because we have previously addressed the need for stronger supervisory action sooner in our prior failed bank reviews and in our Summary Analysis of Failed Bank Reviews, we do not have any additional recommendations related to FRB Richmond's supervisory approach to responding to management's five-year plan in 2007.

Limitations of PCA Assessments

As early as August 2009, State examiners noted that the bank's capital levels were not commensurate with its risk profile, even though Waccamaw remained well capitalized for PCA purposes. The bank remained well capitalized under PCA guidelines until December 2010. Sixteen months later, it became critically undercapitalized.

As noted in our Summary Analysis of Failed Bank Reviews, certain state member banks that failed remained well capitalized under PCA guidelines, even though the applicable examination team noted that the relevant institution's capital position did not support the bank's risk profile. This contrast highlights how significantly PCA quantitative assessments can lag examiners' more subjective assessment of capital in relation to a bank's risk profile. In addition, our report noted that PCA designations may directly contradict an examination team's actual assessment of a bank's capital position and thereby send mixed messages to the board of directors and management. Because we previously issued a matter for consideration designed to address enhancements to the PCA framework, we have no further recommendations related to this issue.

Declines in Financial Performance as a Prerequisite to Aggressive Supervisory Action

As noted in our Summary Analysis of Failed Bank Reviews, many failed banks received at least one double or triple downgrade of a CAMELS composite or component rating prior to the eventual failure. Our report noted that these downgrades highlighted supervisory weaknesses because even when examiners noted material issues and risks that could lead to the failure of a bank, examiners did not take aggressive supervisory action until the bank's financial performance declined.  

During a September 2007 FRB Richmond examination, examiners identified weaknesses in the bank's credit administration and high CRE and ADC concentrations. Examiners noted that the bank's CRE and ADC concentrations were 484 percent and 279 percent of total risk-based capital, respectively. In addition, examiners noted that both ratios exceeded the bank's peer group CRE and ADC concentration levels. Further, examiners advised management to adhere to sound risk management practices for CRE concentrations outlined in recently published CRE guidance—an apparent reference to SR Letter 07-1. Examiners also warned that the bank's expansion plans would strain earnings performance, liquidity, and capital adequacy. In addition to the deficiencies identified during this examination, examiners noted declines in the bank's local real estate market. Despite the weaknesses identified during this review, the bank received a satisfactory rating. The subsequent examination resulted in a double downgrade to the asset quality CAMELS component rating and a board resolution.

During that examination, State examiners noted that the bank's financial condition had deteriorated significantly, as Waccamaw experienced severe loan losses in its CRE portfolio. As a result, the State downgraded the bank's CAMELS composite rating from 2 to 3 and double downgraded the asset quality component rating to 4. Ongoing losses prompted examiners to further downgrade the bank's CAMELS composite rating to 5 during a July 2010 joint examination report. Within 13 months, Waccamaw's CAMELS composite rating declined from 3 to 5.

Similar to state member bank failures noted in our Summary Analysis of Failed Bank Reviews, FRB Richmond examiners had the opportunity for stronger supervisory action, such as CAMELS composite or component ratings downgrades, as early as the 2007 full-scope examination. Many of the weaknesses and risks identified during the 2007 examination remained unresolved and ultimately contributed to the bank's failure. Because we have previously noted the need for a forward-looking examination approach that does not rely on declines in financial performance to take aggressive supervisory action, we have no additional recommendations related to the similar facts and circumstances we noted during this review.